Sunday, June 24, 2001

Fatal Flaw Dooms an Internet Venture

Commerce: The collapse of 'B2B' trading firm Ventro illustrates the folly of getting between suppliers and buyers.

By CHARLES PILLER, Times Staff Writer

SAN FRANCISCO--In 1997, David Perry, a mid-level oil refinery manager who had just completed his MBA at Harvard Business School, had a big idea.

Perry envisioned a technology to let businesses buy or sell products or raw materials anywhere in the world over an online system managed by a neutral provider. His business plan won second place in Harvard's annual competition. Soon after, he drove his decade-old Nissan Maxima west to Silicon Valley in search of venture-fund gold.

The money boys found Perry's idea irresistible. They showered $45 million on him to start a business-to-business, or "B2B," trading system to serve the chemical industry. The legendary venture capital firm Kleiner Perkins Caufield & Byers became a lead investor. Within two years, Perry was widely viewed as a key creative force behind the next wave of Internet-based business efficiency. Analysts quickly projected revenues for the nascent online-exchange industry in the trillions of dollars annually, and Perry's idea helped spawn hundreds of copycats.

Today most of the B2B industry has been decimated. A stock index of B2B companies, compiled by U.S. Bancorp Piper Jaffray Inc., has plunged 80% since a year ago.

Meanwhile, Perry's company, Ventro Corp., has seen its shares fall from a high of $243.50 last year to 39 cents Friday. Ventro, which has no operating revenue, has slashed staff by 80% and faces a shareholder lawsuit filed in federal court in San Francisco that alleges securities fraud by Ventro executives.

Analysts said Perry's B2B dreams have collapsed largely because of a flaw in his business plan. Ventro "attempted to get between the suppliers and buyers of mainstream products," said John Bermudez, analyst with AMR Research, which studies online business markets. "Suppliers don't really want anyone between them and their customers."

This marks a sharp turnaround from early last year, when Ventro's market capitalization was a stunning $11 billion. Former refinery worker Perry even traveled to the world's most prestigious business conclave, in Davos, Switzerland, to lecture top oil executives about how to transform their businesses in cyberspace.

The 33-year-old Perry, who declined interview requests, was born and raised in Magnolia, Ark., near the Texas and Louisiana borders. Like fellow Arkansan Bill Clinton, who hails from nearby Hope, Perry has a soft Southern accent and a magnetic charm that hide ambitions that are anything but small town.

Perry's plan for his first online marketplace seemed tantalizingly simple: Chemical sellers would pay his firm modest transaction fees of 1% to 2% to find new markets. Perry called the firm Chemdex. The idea was that competition would drive prices down and Chemdex would profit by hosting the online exchange as the service grew.

The company launched its service in October 1998. And Chemdex attracted large bioscience companies, such as Genentech Inc. and Becton, Dickinson & Co., which agreed to buy some goods online through Chemdex's registry of suppliers. By July 1999, Chemdex had gone public and Perry used its soaring stock to buy Promedix, an online marketplace for specialty medical supplies.

For a while, Chemdex could do no wrong. Perry recruited highly regarded executives, including Robin Abrams, president of handheld-computer pioneer Palm Inc., as his chief operating officer. Perry also began to collect industry awards as a top entrepreneur. "As soon as we went public, we were getting 50 to 60 phone calls a month from major companies, who said, 'Come here and sprinkle some of your magic dust,' " said Andrew Carragher, former vice president for business development, who left Ventro in December.

"You could not help but to be swept away," said Matt Trerotola, a former Ventro business-development executive who left in October. "There was a kind of electricity that made me more excited about what they were doing than any job in my life."

The early interest in online exchanges inspired Perry to create four marketplaces: for medical supplies (Broadlane), fluid-processing equipment (Industria Solutions), business services (MarketMile) and food services (Amphire Solutions). Chemdex provided its partners, including American Express Co. and IBM Corp., with technology to operate the online-exchange systems, while the partners would find the buyers and sellers. Chemdex received ownership stakes ranging from 19% to 49%. To reflect the diversified approach, Chemdex changed its name to Ventro.

To celebrate the name change, Ventro hosted a party in February last year at its Mountain View, Calif., headquarters, featuring a rock video starring a lip-syncing Perry. Within days, the company's stock skyrocketed to its all-time high. A few weeks later, Ventro sold $250 million in bonds to expand its business. Around this time, Perry borrowed against his stock to buy a jet for his personal and business use.

But this apparent success obscured a looming problem: The Chemdex marketplace didn't work well--as a technology or as a business.

In theory, Chemdex streamlined purchasing with an easy online menu, an advantage over having to flip through catalogs, make calls or fax queries to suppliers.

Yet setting up the Chemdex marketplace cost the company about $50 million and tens of millions more to maintain, according to former executives. Each of the 1.4 million product listings offered by wholesalers--ranging from lab supplies to chemicals and biological reagents--cost Chemdex $3 to $4 to create and an equal sum to change or update, said Pierre Samec, formerly Ventro's chief information officer.

To entice new users, Chemdex charged tiny transaction fees--so it needed to process billions of dollars in transactions just to break even. At its peak, Chemdex pulled in only 144 corporate customers. That service, along with the medical-equipment marketplace, generated less than $30 million in revenue per quarter, according to Securities and Exchange Commission filings.

Big companies sometimes joined online exchanges out of fear of being left behind, then found their own well-established internal purchasing systems to be more efficient, AMR Research's Bermudez said. "DuPont doesn't need Chemdex to find Dow," he said.

To draw new customers, Chemdex had to demonstrate reliable performance, yet its operations deteriorated as volume grew, insiders said. "It's like building the first car: It's going to cost 10 times what you thought, and it won't go as fast" as planned, said Daryl Rolley, a former Ventro business-development executive. And bugs in the system emerged as Chemdex cobbled together nearly two dozen software programs.

By last summer, said Rolley and Dean Dorman, another former Ventro executive, Chemdex was in deep trouble. The Chemdex marketplace began to post losses of $30 million a quarter, according to Rolley. As Ventro opened new marketplaces, costs spiraled out of control because the marketplaces required expensive customization.

"This is when the wheels started to fall off," Rolley said. Ventro's board of directors, over Perry's objections, ordered management to seek a buyer for Ventro, insiders said. The company was on its way to losing $618 million in 2000 alone, and no buyer could be found.

"The professional management Perry had brought in a year earlier . . . they all were jumping ship," Rolley said.

A few Ventro executives exited with stock windfalls of $1 million to $3 million, according to court records, but most left without cashing out. Partly because of the speed of Ventro's decline, its stock value largely evaporated during the "lockup" period when executives could not sell their shares. The big exception was William Klintworth, chief executive of the Promedix marketplace purchased by Ventro, who sold $24 million in stock and gave away stock worth an additional $23.5 million.

Perry sold no stock.

As Ventro's shares collapsed, executives began to joke that instead of traveling by Perry's jet, they ought to be in the back of a bus. Eventually, Perry gave up the jet.

In December, to preserve cash Perry announced that Ventro would shutter the Chemdex and Promedix exchanges and cut the work force by half. His new strategy was to become a seller of technology services to other operators of B2B marketplaces. Then two online marketplaces--one for medical supplies and one for food service--rejected Ventro's software as unworkable and opted to replace it, according to SEC records, industry sources and court documents.

"Even where [Ventro has] a significant minority investment, they are getting thrown out," said George Santana, an analyst with Wedbush Morgan Securities.

Meanwhile, most of the roughly 1,500 B2B exchanges operated by third parties--similar to Perry's original business plan--have also sputtered. Scores of online consortiums, operated by buyers and sellers directly, and up to 200 private trading networks run by one large company also have struggled.

Some online exchanges will certainly succeed, analysts said. Yet it seems clear that one touted benefit of the Internet has been monumentally oversold.

As for Ventro, the company has not posted any operating revenue for the last two quarters. Yet as of March 31, Ventro still had $96 million in cash and investments on hand.

Said Rolley: "Ventro still has a lot of money, but it doesn't have a business model."